Fixed costs depreciating factor

Question

I came across an investment case where I had to calculate ROI. For the fixed costs they took into account a depreciating factor. So instead of plugging in the original fixed cost value of $25m into the ROI calculation, it worked out to be instead (125m/20)* 3 years.

This has left me quite confused. When should apply this into ROI calculations and when shouldn't I?

Answer 1

Hi there,

I think this is an interesting question that may be relevant for many people. I would be happy to share my thoughts on it:

Including a depreciating factor can be useful in certain situations where the fixed asset in question is expected to have a useful life beyond the time horizon of the investment. By including the depreciation factor in the ROI calculation, it allows for a more accurate reflection of the true costs and benefits of the investment over the asset's lifetime.
For example, if the fixed asset in question is a factory that is expected to last 20 years and the investment horizon is 3 years, it would be more appropriate to use the depreciated value of the factory in the ROI calculation, as the factory will be used beyond the 3 years of the investment.
It's worth noting that the ROI formula is not a one-size-fits-all and the inputs and assumptions made in the calculation should be tailored to the specific scenario and context. In some cases, it might be more appropriate to use the historical cost of the asset without any depreciation.

If you would like a more detailed discussion on how to address your specific situation, please don't hesitate to contact me directly.

Best,

Hagen

Answer 2

Hi there,

This case is a bit more “complex” than most. In fact, this is the correct way to truly amortize/depreciate and asset.

BAsically, you should do it this way when the case/interviewer tells you to do it this way :)

You can predict it if they've bought some sort of asset and indicated it has a “life” of x years.